I just had a similar failure on my '04V70R. The transmission and angle/bevel gear are bolted together. Both have a splined shaft output. A splined collar is what couples the shafts. When the collar strips out, no more AWD. The splines of the shaft can also be damaged during a failure like this.
As for the Tranny replacement (that your dealer mentioned), this happens when the dealer is unable to remove the damaged collar from the transmission output shaft and has to replace the tranny. The reason they have trouble removing the collar is because they use an inadequate tool (which I won't get into).
Here is a picture of the collar. You can see the splines are stripped out on one side (the bevel gear side), but the other side is fine (tranny side). I replaced the collar and now all is well. Total cost wqs $85 for the collar, and $100 for new oil seals in the tranny and bevel gear (since I was already there).
As I said, I was fortunate that the collar was the only part that was damaged, and the shafts of the tranny and bevel gear were undamaged. I was also fortunate that I can do this work myself. I can almost 100% guarantee that the dealer would've had to replace my tranny, since their tool wouldn't have been strong enough to remove the collar.
I had to drill two holes in the collar and attach a 5-ton puller, then heat the area with Mapp gas.
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